As of 1 February 2020, Denmark has amended the parent company order (BEK no. 85 of 30 January 2020) concerning up-stream loans to foreign parent companies (the “Order“) to adjust for the departure of the United Kingdom from the European Union in connection with Danish subsidiaries’ upstream loans and guarantees. The amendment to the Order has been necessary to ensure that Danish subsidiaries would continue to be able to provide upstream loans and guarantees following Brexit. This know-how briefing reviews the application of the parent company order and the rules and regulations concerning financial assistance and upstream loans and guarantees as applied to Danish companies.
The General Prohibition
Pursuant to the Danish Companies Act (the “Act“) section 210(1), a Danish company may neither directly nor indirectly make funds available, grant loans nor security (“Financial Assistance“) for its shareholders or management, including the management of its parent company (the “General Prohibition“). The term parent company includes any company that exercises dominant control over the company and applies to public limited companies, partnerships, private limited companies and companies with an equivalent corporate form.
The Upstream Exception
However, pursuant to section 211(1) of the Act, a Danish company may nevertheless provide Financial Assistance for Danish and certain foreign parent companies’ obligations irrespective of the General Prohibition in accordance with the Order issued by the Danish Business Authority pursuant to section 211(2) of the Act. If a parent company is on the white list, the Danish subsidiary can provide Financial Assistance as an exemption from the General Prohibition.
The White List
The Danish Business Authority has issued a revised version of the Order which sets out the permitted jurisdictions for parent companies encompassed by the Upstream Exemption. The jurisdictions must either fall within the EU, the EEA or the two most favourable tiers of the OECD country risk classification. Due to the United Kingdom leaving the EU, the white list has been revised to account for the fact that the UK is no longer an EU member state but falls within the best tier of the OECD country risk classification.
The revised version of the Order lists the following jurisdiction:
- Member States of the European Union, the European Economic Area or Switzerland
- Australia, Canada, Chile, the United Kingdom and Northern Ireland, Israel, Japan, South Korea, New Zealand, Singapore, Taiwan and the United States of America
Previously, Israel and Chile were added to the White List on 29 October 2019 while Hong Kong was removed from the list. However, existing Financial Assistance granted to parent companies incorporated in Hong Kong under the previous white list remains unaffected pursuant to section 2(3) of the Order.
While the Act only applies to Danish companies, the Danish Business Authority has taken the unusual position that the provision of Financial Assistance by foreign subsidiaries of a Danish target company to finance the acquisition of shares in the Danish target company constitutes a circumvention of the Danish prohibition on Unlawful Financial Assistance. This position tends to be more strictly applied that in other EU jurisdictions. The management is therefore obliged to ensure that the foreign subsidiary of a Danish company complies with the Danish Financial Assistance regulations irrespective of whether this would be permissible in the foreign subsidiary’s jurisdiction. It is a matter of debate as to whether the extraterritorial reach of Unlawful Financial Assistance extends to foreign parent companies.
Unlawful Financial Assistance
The prohibition against Financial Assistance set out in section 206 of the Act overrides the Upstream Exception if the Financial Assistance concerns the financing of the acquisition of a Danish company (“Unlawful Financial Assistance“). The prohibition against Unlawful Financial Assistance also applies to subsequent refinancing of the group, if the acquisition finance elements form part of the refinancing, whether directly or indirectly.
The Danish Business Authority takes the position that any Financial Assistance from a Danish target company to a purchaser after the acquisition constitutes Unlawful Financial Assistance, if the proceeds are directly or indirectly applied to repay the acquisition finance facility irrespective of the extent of the time period between the original acquisition and the subsequent refinancing.
This strict approach may post-acquisition result in a number of intricate legal issues in connection with any refinancing of the group as a whole. It requires careful structuring of the acquisition finance facility and a careful separation of the acquisition finance facility from the general operating facility and any cash pooling arrangements and inter-company loans.
To avoid falling within the scope of Unlawful Financial Assistance, the company must follow the Whitewash Procedure to avail itself of the Upstream Exemption.
The Whitewash Procedure
Pursuant to the whitewash procedure set out in sections 206-209 of the Act (the “Whitewash Procedure“), the shareholders’ general meeting may approve the provision of Financial Assistance if the following conditions are duly met:
- The board has conducted a credit assessment of the recipient of the Financial Assistance;
- the board has submitted a written report to the shareholders which includes certain specified information about the proposed Financial Assistance, including: (i) background and corporate benefit; (ii) commercial terms; (iii) review of the consequences for the company’s liquidity and solvency; and (iv) the proposed share price.
- the decision of the shareholders’ general meeting is adopted by a two-thirds majority; and
- the Financial Assistance is granted on market terms.
The Financial Assistance may not exceed: (i) the dividend capacity of the company; and (ii) what is reasonable taking the overall financial position of the company (and/or the group) into consideration. The Danish Business Authority has taken the position that the whitewash procedure can only be initiated within a narrow two-week timeframe just before or immediately after the acquisition.
The whitewash procedure is seldom used in practice as the written report prepared by the board needs to be published online by the Danish Business Authority no later than two weeks before the general meeting. This renders the purchase price per share public domain, which may not be commercially beneficial. Given that the Financial Assistance may not exceed the dividend capacity of the company, it is commonly simpler to distribute dividends from distributable reserves than to comply with the Whitewash Procedure set out in the Act. The target company can declare a dividend to the purchaser and the purchaser can apply the proceeds of the dividend to repay the acquisition debt. Accordingly, a debt push-down can be structured to comply with the Act, and the availability of a debt push-down needs frequently to be examined in connection with an acquisition finance facility.
Ordinary Course of Business Exemption
Pursuant to section 212 of the Act, a company may irrespective of the General Prohibition provide Financial Assistance, if this is in the ordinary course of business. The exemption applies to arrangements which are considered commercially justified and customary both for the company and the line of business in general. They are characterised by being arm’s-length arrangements which a company would generally enter into on an ongoing basis with multiple counterparts, not just the prescribed group falling within the ambit of the General Prohibition. The exemption only applies to the General Prohibition and does not apply to Unlawful Financial Assistance. The term ‘ordinary course of business’ is considered a flexible and dynamic term whose administrative application may differ over time. It has been applied to exempt e.g. cash pooling arrangements from the General Prohibition.
The consequences of Unlawful Financial Assistance include a repayment requirement with added interest. The interest is generally set at the National Bank lending rate plus 2 per cent. In addition, a fine of 5 per cent of the principal amount will generally be levied. Furthermore, security granted in contravention of the General Prohibition and the prohibition against Unlawful Financial Assistance is only binding on the company if the beneficiary was bona fide unaware of the contravention. Professional parties are generally not considered unaware of the application of the General Prohibition and Unlawful Financial Assistance. In the event of a default, the management incurs liability for granting or maintaining the matter.
In summary, the rules and regulations of the Act surrounding Financial Assistance and the application of the Upstream Exemption requires careful review and planning to avoid running foul of the Order and Unlawful Financial Assistance provisions of the Act. Depending on the facts and circumstances, Unlawful Financial Assistance issues may resurface and complicate a subsequent group refinancing or other group-wide arrangements such as cash-pooling or security issuances. The insertion of appropriate limitation language in the financing documentation is therefore imperative to avoid contravening the Act.
20 February 2020